OIL: $1TN WILL NOT RETURN

OIL: $1TN WILL NOT RETURN

Over $1tn is being gambled on high-cost oil projects that will never see a return if the world's governments fulfil their pledge to tackle climate change, according to a new report.

The Carbon Tracker Initiative (CTI) research found that $1.1tn of capital expenditure is expected in the next decade in expensive oil sands, deepwater and Arctic projects but that this investment will be lost if policymakers agree to slash carbon emissions.

"This risk analysis shows that many oil companies are betting on a high demand and price scenario," said James Leaton, research director at CTI and a former PwC consultant. "Investors need to [challenge oil company strategies] to ensure capital is not being wasted." Previous CTI research has shown that about two-thirds of existing fossil fuel reserves cannot be burned if global warming is to be limited to 2C, as agreed by the world's nations.

The new work connects the economics of oil production with the limit on carbon emissions needed to avoid dangerous climate change. It found that only the oil expected to cost less than $75 a barrel to produce, much of which is from conventional onshore wells, can be burned within the planet's 'carbon budget'. The analysts found even when focusing only on the high-cost end – oil costing more than $95 a barrel – $1.1tn was at risk from 2014-2025. Looking further ahead, to 2050, CTI estimated $21tn worth of high-cost oil projects could be wasted.

The region with the highest risk of wasted capital in the report was Alberta. Canada's vast oil sands province is expected to see $400bn of investment by 2025. The companies with the biggest exposure to risk there are Canadian Natural Resources Limited, Suncor and Shell.

Deepwater oil projects in the Gulf of Mexico and off Brazil were also seen as high risk, with ExxonMobil and Petrobras set to invest $100bn each. Ultra-deepwater projects, which drill in ocean depths greater than 1500m, expose Total and BP to the risk of capital being wasted, the report concludes. In the Arctic, Statoil were most exposed, with $22bn capital expenditure projected by 2025.

The report also found that high cost (more than$80/barrel), high carbon projects comprised between a fifth and a quarter of the total capital expenditure expected by the major international oil companies in the next 10 years, with Total at 28% and BP at 18%. But at least a dozen, multi-billion-dollar independent oil companies had at 85-100% of their capex targeted at high cost projects. "They are betting the farm on a high oil price," said Leaton.

The report concluded: "Gambling on a $95 per barrel oil price on behalf of shareholders is risky given that oil prices have dropped to $40 per barrel twice in the last decade. Demand for oil could be impacted by a range of future issues, such as the increasing constraints on emissions [through climate policies], efficiency gains, improvements in technology, and slowdown in the Chinese economy."

Paul Spedding, a former-HSBC oil and gas sector analyst, said: "Many investors are concerned about the growing amount of capital that the oil companies have thrown at low return, carbon heavy projects. The strategies need to be challenged. If this means lower capital investment and higher dividends or buybacks, so much the better."

Craig MacKenzie, investment director at Aberdeen Asset Management, said that unlike Carbon Tracker's previous work on unburnable carbon, the new report dealt with how much demand there may be for oil. "Oil analysts think about demand all the time, so it feeds into the very lively debate about oil prices. This kind of debate now has real traction with investors," he said.

MacKenzie added: "If you look at the return on capital from the majors over the last five years it has been very dissappointing: it has fallen by a third and is now barely covering costs. They need to avoid big splurges of capital on projects that may not pay off. But there has been a sea change in the last year with companies focussing more on shareholder value and not on the volume of oil produced."

Investors managing trillions of dollars have already begun pressing fossil fuel companies to set out their strategies to manage the risk that oil, gas and coal burning may be restricted in the future. But recently ExxonMobil said it thought it was "highly unlikely" that the world would cut carbon emissions enough in order to tackle dangerous climate change. "ExxonMobil's attitude that the risk of climate action is near zero seems an irresponsible attitude to risk management to me," said Anthony Hobley, CEO of CTI.

The new CTI report was welcomed by Christiana Figueres, the UN's top climate diplomat tasked with delivering a global agreement to cut carbon emissions by 2015.

"It enhances the ability of investors to hedge against risks and capture rewards in a carbon-constrained world," she said.

Figueres also backed the growing campaign to pressure universities, municipalities and other large fund managers to sell off their shares in fossil fuel companies. "Divestment may be a question of morality, but it is prudent too," she wrote in the Guardian on Wednesday. In April, Nobel peace prize winner Archbishop Desmond Tutu called for an anti-apartheid-style boycott and disinvestment campaign against the fossil fuel industry.

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